CONSUMPTION POSSIBILITIES

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Consumers have choices in their purchases. These choices depends on their income level and price level of goods and services. Budget line shows various combinations of products which can be purchased with a given money income and knowledge of the prices of the products. This line tells us which purchases are affordable and which are not.

The budget line is constructed by putting the quantities of two products on the X-axis and Y-axis at a given income level. The horizontal intercept is the quantity of product A that can be purchased with quantity of product B equals to 0. The vertical intercept is the quantity of product B that can be purchased with quantity of product A equals to 0.

If a consumer X has an income of $7 to spend on Product A and B, with A's price = $1, and B's price = $0.5. The budget line is illustrated below.

The vertical intercept is at quantity of B = $7 / $0.5 = 14;

The horizontal intercept is at quantity of A = $7 / $1 = 7.

If the price of Product A decreases, the maximum quantity of Product A ( when quantity of B is 0) increases at the same income level, pushing the budget line outwards. If the price of Product A increases, the maximum quantity of Product A decreases at this income level, pushing the budget line inwards towards the origin.

An increase in money income shifts the budget line outward to the right. Likely wise, a decrease in money income shifts the budget line inward to the left. In both cases, the slope of the line will not change.

If product's price is unchanged: A's price = $1, and B's price = $0.5, the following graph illustrate the budget lines at income level of $7, $10 and $14. These lines are parallel, indicating same slope.

The slope of this curve is determined by the ratio of the price of Product A divided by the price of the Product B.

Slope of the Budget line = Price of product A / Price of product B

This slope is negative as consumers must give up some of one good to obtain more of the other goods. The slope of the budget line shows the relative price of one product in terms of the other product - opportunity cost.

If a consumer's income is $7, and price of product A is $1, the following graph illustrated the budget line with price of B changing from $0.5 to $1. Notice that the slopes of the budget lines are different, indicating the price-ratio change.

 

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